Three months after shaking up the pensions market, the government has decided it’s time to do it again. Following the complete ‘liberation’ of the pension market announced in the budget, heralded by the abolition of the compulsion to purchase annuities with pension pots, the government has decided that they will introduce Collective Defined Contribution (CDC) schemes, commonly called ‘Dutch-style collective pensions’ from their popularity in the Netherlands, into the UK market.
These schemes allow the pooling of contributions from employees and employers into a fund every month, but instead of buying units – as in a defined contribution scheme – this cash is put in one giant pot with the contributions of thousands of others and invested. Retirees are given a pension based on a complicated calculation based on age, value of contributions and how the fund has done since they have been in it.
There are positives to these schemes, as the sheer scale of the pension fund allows for the type of efficiencies that smaller individual funds can only dream of. The reduction in administration overhead and transaction costs is of significant benefit to the members and, while hard to quantify, will almost certainly increase the amount the individual can get. CDC schemes can also take on the type of investments that are too large or too long for a standard DC scheme. These can include long-term infrastructure projects of the type the UK government is keen to get pension funds to invest in.
CDC schemes trickle the money back to the retiree from the fund, giving an inter-generational sharing of the risk. This is inherently supposed to smooth returns to the retiree but the very nature of smoothing means that the gains must equal the losses. So if someone is protected from an excessive drop due to market fluctuations, then the corollary must apply that some else’s pension must be lower than it could have been, in order to provide the safety net for the first person.
Last year in the Netherlands, over 60 of the country’s CDC schemes, started cutting their payments to pensioners in retirement because of falling reserves due to poor market conditions, some by as much as 7%. This is in addition to the fact that many of the schemes have not paid out a cost of living increase to their pensioners for quite a few years, as they struggled to maintain their solvency. As a result, the position of pensioners in the Dutch market is not quite as rosy as some pension commentators would have you believe.
Therein lies the rub. Recent reports have calculated that CDC schemes can deliver a payout that could be as much as 30% higher than individual DC schemes, but there are no guarantees; payments can be reduced during retirement. This means that the retiree is still shouldering the risk and may not get what they originally had planned for.
CDC’s have certainly got some strong points. However, going Dutch actually could mean you end up paying for someone else.
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